The Internal Revenue Service has released the first update in five years to its estimates of the tax gap and found that the effort to reduce the amount of unpaid taxes owed by taxpayers has essentially not worked.

The tax gap is defined by the IRS as the amount of tax liability faced by taxpayers that is not paid on time. The new tax gap estimates, based on data for tax year 2006, indicates that the nation’s compliance rate is essentially unchanged from the last review from five years ago, which covered tax year 2001.

The tax gap statistic is a helpful guide to the scale of tax compliance and to the persisting sources of low compliance, but the IRS cautioned that it is not an adequate guide to year-to-year changes in IRS programs or to year-to-year returns on IRS service and enforcement initiatives.

Nevertheless, the IRS found that the previous estimates of $345 billion for the gross tax gap and $290 billion for the net tax gap have now grown to $450 billion for the gross tax gap and $385 billion for the net tax gap. The net tax gap subtracts money brought in through enforcement efforts from the gross tax gap. Compliance rates have also fallen somewhat in the past five years, from 83.7 percent in tax year 2001 to 83.1 percent for the gross tax gap, and from 86.3 percent to 85.5 percent for the net tax gap.

In other words, the voluntary compliance rate—the percentage of total tax revenues paid on a timely basis—for tax year 2006 is estimated to be 83.1 percent. The voluntary compliance rate for 2006 is statistically unchanged from the most recent prior estimate of 83.7 percent calculated for tax year 2001.

Much of the noncompliance came from small businesses, with $122 billion attributed to unreported income on Schedules C and F by sole proprietors and farms.

The following table from the IRS summarizes the new estimates being released today, as compared to the 2001 estimates, along with the total tax liabilities in each year:

“This report shows that closing the tax gap needs to be a major focus of tax reform.  An improved tax code that’s simple and fair to all Americans will help close the tax gap, boost our economy and create jobs,” said Senate Finance Committee Chairman Max Baucus-D-Mont., in a statement.  “In an era when we’re squeezing the federal budget for every dollar of savings, we have to make every effort to recover these lost funds. We simply can’t afford to lose $450 billion while we’re asking each American to pitch in to reduce the deficit.”

There are some caveats. On a relative basis, the tax gap is largely in line with the growth in total tax liabilities, according to the IRS. In addition, some growth in the tax gap estimate is attributed to better data and improved estimation methods. For example, the IRS developed a new econometric model for estimating the tax gap attributable to small corporations which was then applied to newer operational data. Also, large corporation tax gap estimates for 2006 are based on improved statistical methods and updated data. Finally, the data related to individual income taxpayers continues to improve based on improved estimation techniques and newer data.

The tax gap can be divided into three components: non-filing, underreporting and underpayment.

As was the case in 2001, the underreporting of income remained the biggest contributing factor to the tax gap in 2006. Under-reporting across taxpayer categories accounted for an estimated $376 billion of the gross tax gap in 2006, up from $285 billion in 2001. Tax non-filing accounted for $28 billion in 2006, up from $27 billion in 2001. Underpayment of tax increased to $46 billion, up from $33 billion in the previous study.

Overall, compliance is highest where there is third-party information reporting and/or withholding, the IRS noted. For example, most wages and salaries are reported by employers to the IRS on Forms W-2 and are subject to withholding. As a result, a net of only 1 percent of wage and salary income was misreported. But amounts subject to little or no information reporting had a 56 percent net misreporting rate in 2006.

While compliance rates were steady, with 83 percent voluntary participation and 86 percent after audits and enforcement, the difficulty of compliance and administration remained significant drivers of the gap, Baucus noted.  The $450 billion gap, from a perspective of federal funding, represents a sum nearly four times the entire 2011 budget of the Department of Veterans Affairs.

Baucus, as part of his work on tax reform, convened a hearing of the Senate Finance Committee last June to address the relationship between the complexity of the Tax Code and the tax gap.  At the hearing, he said Congress should pursue an effort to simplify the code and reduce its complexity as a means of narrowing the gap.  He noted that taxpayers and businesses spend more than 6 billion hours each year complying with their tax responsibilities, and the National Taxpayer Advocate added that if those resources were dedicated to one single industry, it would be one of the largest in the U.S. and employ more than 3 million full-time employees.